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China's second largest mobile operator China Unicom (CHU - Analyst Report) added 3.34 million subscribers in October, up 1.77% from the prior month. This takes the company’s total customer base to 192.38 million.

The company’s GSM subscriber base expanded to 159.23 million with the net addition of 0.42 million customers, while its 3G subscriber base increased to 33.15 million with the net addition of 2.92 million. This is the third consecutive month that China Unicom added more than 2 million 3G users.

China Unicom’s 3G business is growing rapidly, and surpassed its target of expanding the 3G user base beyond 25 million by the year-end. The rapid growth has been particularly driven by Apple Inc.’s (AAPL - Analyst Report) iPhone sales. China Unicom enjoys the exclusive right to distribute iPhone in China since October 2009. The addition of Apple’s iPad tablet, talks for which are ongoing, would further draw 3G subscribers, eventually leading to higher average revenue per user.

Nevertheless, intense competition in the domestic wireless market, in particular from China Mobile (CHL - Snapshot Report) and China Telecom Corp. (CHA - Snapshot Report), and high levels of marketing and promotional expenditures related to 3G service deployments are restricting its future growth.

Coming to the fixed-line business, the company is poised to benefit from the stabilization and expansion of fiber optic service in its broadband business. China Unicom added 0.512 million broadband customers in October bringing the total number to 55.05 million. But the company is experiencing significant declines in its local access lines due to the impact of the ongoing fixed-to-mobile substitution. Erosion in the fixed-line subscriber base continues with approximately 0.278 million customers lost in October, taking the total number to 94.3 million.

Consequently, 3G and fixed-line broadband businesses are expected to remain under pressure due to increasing depreciation and amortization expenses, network, operations and support expenses, as well as selling expenses for the remainder of the year. We believe these expenses will have an adverse effect on the company’s future profitability, free cash flow and margins.

Despite the strength in 3G user growth, we have a long-term Underperform rating on China Unicom. The stock retains a Zacks #5 Rank (Strong Sell rating) for the short term (1–3 months).

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